Tilray Brands, Inc. (TLRY) Q3 2020 Earnings Call Transcript

Good morning. My name is Kensey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aphria Inc. Q3 Quarterly Investor Call. Thank you. Ms. Katie Turner, you may begin your conference.

Thank you, Kensey. Good morning, everyone. We appreciate you joining us to discuss Aphria, Inc.'s financial results for the third quarter ended February 29, 2020. On today's call are Irwin Simon and Carl Merton. By now, everyone should have access to the earnings release, the financial statements, MD&A, and investor presentation, which are available on the Investors section of Aphria's website at www.aphriainc.com. The financial statements have been filed with SEDAR and EDGAR. Before we begin, please remember that during the course of this call, management may make forward-looking statements. These statements are based on management's current expectations and beliefs, and involve known and unknown risks and uncertainties which may prove to be incorrect, and actual results could differ materially from those described in these forward-looking statements. Please note the text of Aphria's earnings release and the financial filings issued yesterday for a discussion of the risks and uncertainties associated with such forward-looking statements. I'd also like to note that we are conducting our call today from our respective remote locations; as such, there may be brief delays, cross-talk or other minor technical difficulties during this call, and we thank you in advance for your patience and understanding. And now, I'd like to turn the call over to Irwin.

Thank you so much, Katie, and good morning, everyone. We appreciate you joining us today to discuss our strong third quarter financial results. Before I get into our robust sales growth, brand strength, profit improvements, and strong balance sheets and cash flow, I'd like to comment on the COVID-19 global health crisis and what we're experiencing across our operations in the industry. First and foremost, our thoughts and prayers go out to all those affected by this virus. As the situation has continued to rapidly evolve, our number one priority has been ensuring the health and safety of our employees and their families. Our leadership had a plan in place ahead of this, and I'm proud to say we took decisive action and executed well. We're fortunate that all our facilities have been deemed essential by their respective governments. This is a privilege and a responsibility we do not take lightly. It's our privilege to continue to be fully operational across our Canadian and International operations, as we serve our valued patients and consumers, providing them with our medical and adult-use cannabis products. We remain committed to providing best-in-class products and services during this time of need and uncertainty as a result of COVID-19. And we will continue to work with local, provincial, and federal regulators to help eliminate the illicit market. At the same time, we have a tremendous responsibility at Aphria to our employees, their families, and the communities we operate in. We took decisive action and implemented heightened safety measures in our facilities to protect against and prevent the spread of COVID-19. These include, but are not limited to, staggering work schedules, redesigning work facilities to ensure appropriate social distancing, and significantly enhancing sanitation and regular cleaning procedures. We are immensely grateful to our employees who work in our production facilities and have proactively taken action to reinforce our appreciation and our commitment to them. At Aphria One, we've accelerated and implemented a planned wage increase for all hourly employees and implemented a company-paid lunch program for all employees. We're also very pleased to have not had any layoffs, and the vast majority of our operational employees continue to report to work each day to maintain production and shipping schedules. In fact, we are even hiring for certain operational roles. Our teams continue to work closely with our global supply chain partners to prevent and minimize any potential business disruptions. In Canada, we took preemptive measures to ensure alternate supply sources if needed. Like many consumer packaged goods companies, Aphria also experienced a prior-to-lockdown consumer demand at the beginning of the pandemic, but more recently, consumption has returned to more normalized pre-COVID-19 levels for all regions, except Quebec, where cannabis sales remain at even higher levels. Our Canadian medical cannabis has experienced increased demand since the outbreak of the virus. In Germany, CC Pharma, an important distributor of pharmaceutical products, as many of you know, has seen a 50% sales increase. Our team is taking steps to secure supply and is closely monitoring the situation should any countries in the EU change their border policy as a result of COVID-19. Our team has accomplished a lot on all fronts. And as I said before, what a difference a year makes. Last year at this time, during our earnings call, it was a totally different story. At Aphria, we're setting ourselves apart from the rest of the cannabis industry. We have generated some of the strongest sales growth and have one of the strongest balance sheets and cash positions, compelling consumer brands, as well as diversified global business. Our Q3 results demonstrate this with the hard work of our strong team. We generated a 65% increase in net sales revenue from the prior quarter, our fourth consecutive quarter of positive adjusted EBITDA. Consolidated adjusted EBITDA in the quarter more than tripled to CAD5.7 million from the prior quarter. Most notably, adjusted EBITDA from cannabis operations increased 78%, and adjusted EBITDA loss on business under development decreased by 20% in the quarter. In an industry full of cash burns, we're pleased with our ability to generate consistent results. During the month of January, we also raised approximately CAD100 million in capital to further build and strengthen our balance sheet. We continued to possess an enviable balance sheet and cash equivalents to fund planned Canadian and international growth. As they say, cash is king. A cornerstone of our long-term strategy is to focus on the highest return priorities. Our growth has enabled us to be one of the only profitable publicly traded licensed producers in the industry. We believe we have the appropriate capital structure for our business, which provides us with strong financial flexibility well into the future. This continues to further differentiate Aphria in the cannabis industry. In Q3, we demonstrated our ability to continue to be a leading producer with both Aphria One and Aphria Diamond fully-licensed and operating at 100%. Aphria Diamond is already in its second crop. I want to thank the Mastronardi brothers, our partner here, for all their help to make sure this happened. In Leamington, we are consistently working to generate greater yields at lower costs. We're pleased that in Q3, cash cost per gram decreased to below CAD1. We’re excited about the tremendous growth opportunities we now have as a result of expanding our total annual domestic production capacity in Canada, as well as our strong medical and adult-use brand sales, extraction capabilities, and our ability to export EU GMP products and white label opportunities. From enhancing our global team, our brand building activities, new facility and production capabilities to investing in new systems and technology, Aphria is well-positioned for future growth. We have compelling brands for patients and consumers across broad demographics with five high-quality brands including Solei, RIFF, Good Supply, Broken Coast, and, of course, our Aphria medical brand. We are increasingly connecting with consumers through our medical and adult-use brand positioning and innovation to drive growth. We added 100 basis points to our market share in Ontario during Q3. We added 400 basis points to our share in Alberta. Aphria maintains a 77% share across all brands on vapes in Ontario. We increased our national share in each of our last four quarters. We continue to make progress in Ontario, where in March, Aphria had three of the top five brands. Good Supply was number one, Solei was number two, and RIFF was number four according to OCS. Aphria's success will continue to be driven by our differentiating portfolio, brands, and products aimed at delighting distinct consumer segments. We look forward to launching our edibles, beverages, and topicals in the near future. We believe the quality of our brands remains unmatched in the industry. We have a strong foundation in Canada where we expect momentum to accelerate. That strong foundation also helps us to leverage e-learning to implement them on a market-specific basis in Germany, Latin America including Colombia, Argentina, and Paraguay, as well as other international markets. Before I turn the call over to Carl, I want to highlight yet another way Aphria is doing its part to support local communities, seniors, and healthcare workers during this health crisis. We're very pleased to have made a major donation to the Erie Shores community of hospitals. This will help them acquire additional healthcare equipment and resources. We've also implemented a program where employee volunteers and many can purchase and deliver groceries and other necessities to seniors and healthcare workers during this challenging time. It is great and important for us to give back. We're thrilled to have made contributions to the communities and the people that support Aphria. Our core value of supporting the communities to which we belong, especially in these uncertain times, serves as a driving force behind our strategic decisions and outlook. In summary, our mission is clear: to be the premier global consumer packaged goods cannabis company with our medical and adult-use cannabis brands. We are building brands that we believe resonate with consumers today and well into the future. Consumer behavior has already changed, but this change has been accelerated. Through our data insight and understanding of consumer preferences, we believe we are well-positioned to capitalize on these changes in the cannabis marketplace. I would like to thank and give a huge thanks to my leadership team, the board of directors, and our associates around the world for all their efforts in achieving sustainable results and their tireless work that continue to keep Aphria moving forward. I'm proud of the entire team's ability to remain focused while navigating through this unprecedented time and take decisive action to adapt our business while protecting our employees’ health. With that, I would like to turn the call now over to Carl.

Thank you, Irwin, and good morning. Please note, all financial references are in Canadian dollars unless I mention otherwise. Also, some of the financial metrics discussed on this call are non-IFRS measures, and I refer listeners to the company's MD&A for an explanation of how the company calculates those metrics. I want to start by highlighting three key items from our results. These quarterly results do not include any impairments, inventory write-downs, or provisions for future sales returns. As Irwin discussed, we continue to execute on our growth initiatives and prioritize profitability with long-term growth and success in mind, especially now, that we are in the wake of a macroeconomic uncertainty as a result of the COVID-19 global pandemic. We are pleased with our financial results, particularly our cannabis revenue growth, sequential positive adjusted EBITDA, positive operating income, and our ability to maintain a strong balance sheet and cash position. The strength of the Aphria team has become even more evident as the COVID-19 health crisis continues. We are doing everything we can to continue serving our customers and executing our strategic initiatives. Irwin provided an overview of the disciplined and well-planned actions we have taken across our business, and I also want to highlight a few additional industry data points related to COVID-19 that are important to keep in mind as we move forward. These include that the Ontario, Alberta, and British Columbia Control Boards were closed to deliveries and shipments for a week at the end of March for year-end inventory counts. The Ontario Control Board temporarily canceled two weeks of purchase orders from all licensed producers while it assesses its inventory balances and is generally expecting lower volumes due to COVID-19. The Alberta Control Board's replenishments are down 40% since COVID-19. In BC, retail stores have closed or are voluntarily closing due to COVID-19 concerns. Importantly, in BC, they are trying to convert their brick and mortar locations to click-and-collect. Conversely, in Quebec, e-commerce sales are up 200% since COVID-19 restrictions came into place, and sales at their brick and mortar locations are up 40%, further demonstrating what Irwin referenced with Aphria's sales being higher in Quebec compared to pre-COVID-19 restrictions. Additionally, our medical sales are up 18% since COVID-19 restrictions came into place, although we proactively decreased selling prices 10% to help patients manage current cash flow concerns. There are many variables related to this global health crisis, and we will continue to monitor them closely and react appropriately where and when needed. From a liquidity perspective, we believe we have more than sufficient funds for at least the next 12 months. Our cash balance at the end of the quarter was CAD515 million. We maintain undrawn line of credit facilities of just under CAD4 million and an accounts receivable balance that is largely with Crown corporations totaling almost CAD80 million due within the next 60 days. Our accounts payable balance at quarter end was CAD137 million, and we do not have any debt maturities occurring in the next 12 months. Our next maturity is in June of 2021 and it is less than CAD1 million. We do not anticipate any issues with our debt covenants. Further, to proactively preserve cash in this operating environment, we ceased all material new CapEx projects in mid-March and have eliminated over CAD4 million from our anticipated sales, marketing and promotion spend in the fourth quarter. Difficult times require strong leadership and they require communities to come together to support one another. At Aphria, our team is up for the challenge and is executing every day. Before getting to our financial results, I would like to take a moment to discuss the supply and demand challenges we faced this quarter. As we previously discussed, the receipt of Aphria Diamond's cultivation license last November occurred later than we had anticipated. This delay led to a reduction in the amount and variety of finished product to meet market demands for our brands. As a result, as we announced last quarter, we supplemented our own supply by purchasing wholesale flower for resale. During the second and third quarters, we purchased almost CAD30 million of dried flower on the wholesale market, of which approximately half was sold during Q3. The sale resulted in approximately CAD20 million in net revenue with a gross profit of over CAD5 million. If we had been able to produce the product ourselves, we believe we could have recorded an additional CAD7.6 million of gross profit and adjusted EBITDA in the third quarter and an incremental 1,360 basis points on our adjusted cannabis margin. These figures are based on assumptions set out in the MD&A, including an all-in cost of sales of dry cannabis per gram of CAD1.69. At the end of the quarter, we maintained almost CAD14 million of purchased dried flower in our inventory, all of which we anticipate selling in Q4. As discussed in our last quarterly conference call, at last quarter end, we identified an excess amount of extraction-grade THC-dominant harvested cannabis and trim in inventory that we plan to sell in the wholesale market during Q3. We also identified that we had a shortfall in CBD oil, where we're looking to the wholesale market for replenishment. As a result, we sold CAD10 million of excess lower potency extraction-grade THC-dominant harvested cannabis and trim, which the customer accepted title and control to, even though we are temporarily storing the product for the customer. We also purchased CAD7.5 million of CBD distillate. These two transactions were with the same counterparty, and I confirm that these transactions are the only transactions we have engaged in with a third-party extractor. In the third quarter, we harvested approximately 31,000 kilograms of cannabis. This includes a partial quarter of harvest from Aphria Diamond. Extrapolating for the last two weeks of Aphria Diamond harvest and annualizing its harvest suggests that Aphria's facilities would have harvested at an annualized production rate of 175,000 kilos at the end of the quarter. Our financial results continue to demonstrate our ability to continue to gain share. They demonstrate our continued focus on leveraging our cultivation expertise into lower cost per gram and our focus on remaining adjusted EBITDA positive. Net revenue in Q3 increased 96% over the prior year period and almost 20% from the prior quarter to CAD144.4 million. This net revenue is comprised of CAD88.3 million of distribution revenue, CAD55.6 million of cannabis revenue, and CAD0.6 million of insurance recoveries. Distribution revenue increased almost CAD2 million from CAD86.4 million in Q2, and cannabis revenue increased 65% from CAD33.7 million. Adult-use net revenue increased 54% from the prior quarter to CAD44.7 million. Wholesale revenue was CAD11 million, and we do not anticipate this level of wholesale revenue occurring next quarter. The company sold 14,014 kilogram equivalents of cannabis in Q3, up 98% compared to 7,062 kilogram equivalents sold in Q2. Adult-use cannabis accounted for 8,171 kilogram equivalents, and medical cannabis accounted for 1,352 kilogram equivalents. The average gross selling price of adult-use cannabis increased to CAD5.46 per gram in Q3 compared to CAD5.22 per gram in Q2, primarily as a result of a shift in product mix. The average gross selling price of medical cannabis, exclusive of wholesale, decreased to CAD6.41 per gram in Q3 compared to CAD8.16 in Q2, primarily related to the introduction of a compassionate pricing program in the quarter. During the quarter, our cash cost per gram decreased from CAD1.11 last quarter to CAD0.93, bringing our cash cost per gram back under CAD1 as it has been in the past. Our all-in cost per gram decreased from CAD1.98 a gram to CAD1.69 a gram. We continue to work to lower these amounts and are pleased that the completion of the Aphria Diamond facility has already aided in lowering our cost per gram. Adjusted cannabis gross profit increased to CAD23.7 million in Q3 as a combined result of both increased sales and a reduction in costs. Adjusted cannabis gross margin was 42.7% in Q3 compared to 56.6% in Q2. The decrease was primarily due to the sale of cannabis that was purchased from other licensed producers and the lower margins recorded on wholesale revenues. As I mentioned earlier in my remarks today, had we been able to sell product cultivated at Aphria Diamond instead of amounts purchased on the wholesale market, we believe we could have recorded an additional CAD7.6 million of gross profit and adjusted EBITDA in the third quarter and an incremental 1,360 basis points on our adjusted cannabis margin. These figures are based on assumptions set out in the MD&A included in our all-in cost of sales of dried cannabis per gram of CAD1.69. Adjusted distribution gross profit increased slightly to CAD11.4 million in Q3 from CAD11 million in Q2. Adjusted distribution gross margin increased slightly to 12.9% in Q3 compared to 12.7% in Q2. SG&A costs of CAD50.9 million in Q3 were CAD1.7 million higher than in the prior quarter. The increase in SG&A was primarily related to a CAD1.8 million increase in transaction costs. During the quarter, we reclassified marketing salaries and wages from marketing and promotion costs to general and administrative costs consistent with all other corporate salaries and wages. Operating income in the third quarter was CAD8.7 million compared to a loss of CAD9.6 million in the prior quarter. We are extremely pleased to have returned to operating profitability, an important milestone in our financial success. We reported net income of CAD5.7 million or CAD0.02 per share compared to a net loss of CAD7.9 million or a loss per share of CAD0.03 in Q2 and a net loss of CAD108.2 million or CAD0.43 per share in Q3 last year. Further, for the year to date, we reported net income of CAD14.2 million or CAD0.06 per share compared to a net loss of CAD33.3 million in the prior year or a loss per share of CAD0.13. In an industry full of cash burns and heavy adjusted EBITDA losses, our focus remains on generating positive EBITDA. For the quarter, we are pleased to continue our trend and report a fourth consecutive quarter of positive adjusted EBITDA. Consolidated adjusted EBITDA in the quarter more than tripled to CAD5.7 million from the prior quarter. This includes adjusted EBITDA from cannabis operations of CAD6 million and adjusted EBITDA from distribution operations of CAD2.6 million but is partially offset by an adjusted EBITDA loss from businesses under development of CAD2.9 million, down from an adjusted EBITDA loss of CAD3.5 million in the prior quarter. Most notably, adjusted EBITDA from cannabis operations increased 78%, and the adjusted EBITDA loss from the business under development decreased by 20% in the quarter. Moving to liquidity, as Irwin said, we continue to possess an enviable balance sheet made even stronger by our CAD10 million capital raise in the quarter, including a strong cash position, and a robust capital structure within our industry that provides flexibility during uncertain macroeconomic conditions and a cap table with minimum potential dilution. As of February 29, 2020, the company had cash of CAD515.1 million to fund planned Canadian and international growth and deal with any COVID-19 pandemic-related financial impacts. While all new material CapEx projects are currently on hold, we still have approximately CAD30 million to spend on our German expansion and CAD40 million to spend on our Colombian expansion. Further, we anticipate another CAD25 million to CAD50 million may be necessary for working capital investments. These working capital needs are likely to decrease over a reasonable time period. As a result, this leaves approximately CAD400 million plus the cash generated from future operations, all of which is available for future strategic initiatives. We believe this is more than sufficient to take advantage of any attractive distressed asset sales in Canada, U.S. expansion, or other income-statement accretive opportunities and protect us from any adverse effects of COVID-19. In Q3, we increased our cash position by more than CAD17 million. Cash inflows included net proceeds of CAD99.7 million from our equity raise, CAD9.7 million from the continued liquidation of our non-core investments, CAD4.5 million from increases in CC Pharma's drawdown on its line of credit, approximately CAD800,000 related to capital asset sales, and CAD400,000 related to warrant exercises. Cash outflows in the quarter included approximately CAD54.4 million for investments in working capital, CAD38.3 million in CapEx, and a CAD2.5 million OpEx burn, exclusive of changes in our working capital. Included in the investments in working capital were the already mentioned purchases of dried flower in the wholesale market of approximately CAD30 million. Turning to our outlook for fiscal 2020, absent COVID-19, we believe we would have achieved our guidance previously provided. However, the uncertainty around the global pandemic has now made it very difficult for us to accurately forecast our year-end results. This includes the risks associated with EU member states closing their borders to exports and the uncertainty with respect to cannabis purchases in the major provinces we serve, all as more fully disclosed in our MD&A. As a result, we are suspending our previously announced guidance for revenue of CAD575 million to CAD625 million and adjusted EBITDA of CAD35 million to CAD42 million for fiscal 2020. I would now like to also provide further comment on what Irwin referenced on Aphria's position within the cannabis industry. At this point in the industry's history, it has become convenient to blame a combination of industry oversupply and lack of retail rollout for poor sales growth. We believe these statements are too simplistic in nature. We believe we have found and can continue to find pockets of industry undersupply. They are there for the taking. The key is to be able to identify them, possess the capability to supply them, and build brands, products, and product line extensions around them. We believe that through our data insights and understanding of consumer preferences, we are well-positioned to continue to take advantage of the opportunities these undersupplied markets provide. Aphria continues to be unmatched on a variety of financial metrics including our record of consecutive quarters of positive adjusted EBITDA, focus on profitability, operational efficiency, and cannabis revenue. Our strong cash position will support our strong performance and underline our ability to hold out through the uncertain times ahead. In summary, at Aphria, we have the greenhouse space, cultivation expertise, extraction capacity, automation technology, differentiated brands, product innovation, and raw materials to position us for success. As we gain scale, we will gain efficiencies in Canada. Those efficiencies will allow us to build out international distribution for our medical and adult-use cannabis. We are pleased with our financial results this quarter, and we continue to execute on our strategic priorities, namely, a stronger, more profitable company as we continue to provide support to our employees and the communities we operate in during these difficult times. We believe that Aphria's competitive advantages, brand strength, strong balance sheet, and the resilience of our employees continue to position the company well as we navigate through these challenging times. We remain confident in our ability to create long-term shareholder value. That concludes our formal remarks. Irwin and I are now available for your questions. Kensey, back to you for questions.

Our first question comes from Owen Bennett with Jefferies. Please go ahead; your line is open.

And just a couple of questions please. First of all on the CapEx, and what CapEx has actually been spent, just a bit more color on that, and linked to that are you still building Germany out and sort of linked to that once more, anything on Europe shipments in Q4 into Europe or is that kind of wait-and-see depending on what happens with COVID. Thank you.

Carl, you want to take that. Just in regards to CapEx, I think the big thing is this year, you know we've always spent CapEx on enhancing and upgrading our facilities, and we pulled back on a lot of those things. We finished Aphria Diamond; there are some things in the processing area we'll continuously do at Aphria One. In regards to Germany, it is just about finished and we will get that up and going. I was there a couple of months ago, but you know we're going to always spend CapEx and you know it is at 5% of sales each year, etc. But we have just stepped back and sort of said wait now, our facilities are in pretty good shape, where can we more or less invest CapEx and take out costs and become a much more efficient company. So, our greenhouses are in good shape. There's some work that we need to do on processing which we will continuously do, and we will get Germany finished, which we're very close to completing today.

I just reiterate Germany continues to move forward. Most of the work is done and there is a bit of a disproportionate between the work done and the cash we've paid at this point. There are some cash payments that are coming up shortly. We are very focused on being ready for the German market as soon as possible and are not letting this delay impact that project but where we have opportunities to defer CapEx and starting new projects we have seized those opportunities.

I don’t think it’s deferred CapEx; it’s just looking at the return on invested capital and where we need to spend CapEx to really get efficiencies out there. And, there’s plenty of CapEx you can spend, but we will not spend CapEx unless it meets our hurdle of return on invested capital.

Our next question comes from the line of Chris Carey with Bank of America. Please go ahead. Your line is open.

So clearly some strength in different areas. I guess the one part I'm just trying to reconcile right is this dynamic of where EBITDA is improving sequentially, but free cash burn has deteriorated sequentially. And just doing the math, it's - you know it's about the widest gap we've seen between EBITDA and free cash burn on record. And I'm just trying to understand as you look forward on working capital commitments or maybe if you could offer some insight on why this is the case this quarter and when this positive EBITDA starts to flow through and show up on the free cash flow statement or the cash flow statement as well. And then I have a follow-up.

So Chris, the free cash flow decrease in the quarter is really being driven by our investments in working capital. I think it's important to remember that we had Aphria One coming online with its first harvests, and we expect to see an increase in working capital again next quarter. It is part of what I said during my portion of the discussion. As Aphria Diamond continues to ramp, there's five, six weeks of additional harvests that become available that haven't reached a point where you can release them to the public; that number is going to build. It then goes into accounts receivable to control boards where you're waiting at least 60 days to collect on it. That's really what you're seeing this quarter. If you exclude the investment in working capital in the quarter, our OpEx burn was less than CAD2.5 million.

And on top of that, you're also seeing us, as Carl talked before, buying cannabis from other producers and building inventory which means some of that has not been sold through yet. So you're not seeing the cash net return here, and that's a big number that is there. So, you know the big thing, and again as we move into some of our biggest quarters. If you look at it, Aphria Diamond now has come online. So we've had to invest in regards to growing there. We've purchased, as Carl talked about, close to CAD18 million or so outside in cannabis, so we're investing cash to ultimately turn it into product with margins, and that cash will come back in the next 30, 60, and 90 days.

Okay, understood. And then just as my follow-up, and you did allude to it there, I guess, you know just functionally right, so could - you did produce, I believe over 30,000 kilos in the quarter. So you're continuing to have nice harvest, and just functionally was it that what you were producing was not necessarily the SKU that you needed for retail listings and that's why you went out in the market to purchase product. I’m just trying to understand the gap between what was produced and what was sold and the decision to purchase wholesale and effectively just so I can understand how we get the cannabis gross margins back to where they were as you transition to more of the sales coming from your own product produced. Thanks so much.

So Chris, I think it’s important to remember there is always that almost one quarter delay between when you harvest something and when you realistically have it out as a sale; last quarter our harvests were not 31,000, and so we identified that there were opportunities on the demand side to fill if we had more product, we didn’t have it because Aphria Diamond's license was later than we had thought, so we bought that cannabis. It was just we kind of replaced the hole that was going to happen in Q3 as we knew harvests were ramping for us that would be available to sell in Q4 but just weren't available in Q3. So it goes back to that five- to six-week delay after you harvest something before that product is in a position to really go out the door by the time it gets dried, it goes through your packaging process, and then clears all the QA and QC tests including microbiology, pesticides, potency, all the different tests that we're mandated to do by Health Canada.

Our next question comes from the line of Andrew Carter with Stifel. Please go ahead. Your line is open.

Yes, thanks just a couple questions. Number one on the CAD11 million in wholesale; could you quantify by chance how much that helped kind of profitability in the quarter? And appreciate you kind of mentioning - kind of get it that you would have achieved the guidance after COVID-19, but which implied a pretty healthy scaling of the business in the fourth quarter. Would that be put off two quarters? I think what's the kind of the impediment there? Is it getting really all 100% internal supply moving away from wholesale and getting a good run rate on second-generation products? Thanks.

So, Andrew, thanks for asking the question. On the wholesale product, we are at about a 10% margin on that and that basically falls directly to the bottom line on the EBITDA side. And I apologize, but I missed the second half of the question.

Yes. So I'll ask a just a little bit better. I would say in this, in kind of the fourth quarter implied a pretty healthy kind of EBITDA margin in the business apps that COVID-19, I get that. It included two - a couple of things included a stepwise increase in cannabis, a lot more internal production. If I had that right and then obviously second-generation products will be much more meaningful. I mean is that delayed two quarters? I mean, when do we really start to see the business start scaling or is that just with so much uncertainty around COVID-19, it's really even difficult to even say that at this point?

So, I think I’ll say the deferral. You know, when you’re in different rooms, but step back for a second - I think as you saw the increase in the third quarter, that will continue. When you have our six brands gaining share and continuing to gain share, that's going to be a big lift to our sales. The other thing is one of the biggest problems is just having products to sell, and now with Aphria Diamond coming on, we will have the ability to sell a lot more products. We have sold close to 100,000 vapes, and we'll continue to sell a lot more of vape products. We don't have them yet, but we will be rolling out our edibles, and that's going to be a big part of it. But I think the big thing, which is key, is that the consumer has really accepted our product, likes our product, and they just want product to supply for them. Each quarter, more and more stores come online, and I think the other big opportunity, as we look at it, is as we sell more and more product through e-commerce. The biggest opportunity for us is that we came out with good product, good pricing, good selection, good supply. We're taking sales away from the illicit market, and that's the key here. Is how we take sales away from the illicit market because today within Canada, 75% of cannabis still goes through the illicit market, and there are 700 stores, 800 stores in Canada today, that are going after that illicit market and opening additional retail stores.

Our next question comes from the line of Aaron Gray with Alliance Global Partners. Please go ahead. Your line is open.

I guess, first off, I just want to kind of ask about overall kind of sales price, you guys saw a nice sort of uptick during the quarter and there has been a lot of conversation in the market about more competition, especially in kind of deep value. You guys have done seemingly a real nice job of increasing your market share with your own brands. So can you talk about some of the market dynamics there? What you're seeing in terms of pricing pressure and how you feel like that should evolve over the next couple of quarters, especially as your 2.0 products continue to roll out? Thanks.

I'll take some of it, then Carl will take the other part of it. Number one, our sales team working with Southern Glazer have done a great job with boots on the street, have done a great job of getting display and getting products. And I think the big part of it is just we've got more and more products that we've been able to get into the stores. The big thing also is the relationships and that we've built and displays. I come back and say where the quality of our product has continuously improved and increased with our flowers, with our vapes, and when you gain share. So distribution is number one, innovation is number two, and consumer awareness about our products is increasing as they know and accept our products. In regards to price, the big thing is you have to promote; you have to drop the prices when your product is not selling, and that's not been our case right now that we've not had to go out there and discount our products because our products are selling. Our biggest complaint is that you can find our products if we are out of stock. Carl, you want to add anything?

I'll just add that we haven't seen the pricing pressure, as Irwin said. And I really think that's a function of how we've priced all of our brands and when you look in each segment that those brands are competing against, they are all priced competitively against the other brands in the space. We're not trying to sit out there and take the number one, number two selling price inside of a segment. All of our brands are priced median or just slightly below it, and I think that's a big part of our success as well.

All right, great. Appreciate that. Internally, it seems evident in the market share gains. If I could just squeeze in one more question. Just as we look at the fourth quarter, I can certainly appreciate the decision to suspend guidance, but as you think about all the puts and takes, you do have more stores that will come online, some continued market share gains, but obviously a lot of unknowns with COVID which has been impacting for about a month now. If everything were to stay as it is now for the remainder of the quarter in terms of curbside pickup, delivery, and what stores are closed, how do you expect kind of sales to trend sequentially? So, any color there would be helpful. Thanks.

So, we pulled the guidance, Aaron. There was a reason we did that, and we suspended the guidance. There is just so much uncertainty, and individual control boards, when you talk to them, some are seeing things go up, some are seeing sales go down, some are just trying to be careful to make sure that they don't have excess amounts of inventory in their stock. And so I think you’re seeing a move at the control boards to lower purchases on an individual purchase with a greater cadence of purchases just to be safe. They have learned from what happened in the 1.0 rollout that just buying product because it's available isn't an effective strategy for them. And that's what we're seeing. But it just puts us in a position where we're just unable to comment on what that looks like other than providing the pieces we provided in the call, where we gave you the little pieces in each individual country of what we're currently experiencing. The real problem is nobody knows what we're going to experience tomorrow.

Our next question comes from the line of John Zamparo with CIBC. Your line is open.

I wanted to follow up on the wholesale question from earlier. At what point do you think you'll get to sourcing all of your products internally? Is it likely to be in fiscal Q4 or later in 2020? And then selling wholesale, can you talk about market conditions there and the sale that you had in the quarter? I mean, do you view this as somewhat sustainable or should we view it as kind of opportunistic and one-time?

So, I think, I said during my remarks we don't anticipate duplicating that wholesale sale. It was kind of a one-time position. We had excess inventory in a specific part of our inventory and we wanted to make an adjustment there, so we sold it to someone who was looking for it. As it relates to purchasing flower, we have taken advantage of that market when it proactively benefited us. That was primarily in Q3, and we have a little bit left over that's going to be available for Q4. Our intention is not to remain in that market. We have the capability to produce up to 255,000 kg's from our two facilities. Buying more on a long-term basis doesn't make sense. It just made sense in this very limited short-term opportunity.

Our next question comes from the line of Pablo Zuanic with Cantor Fitzgerald. Please go ahead. Your line is open.

Good morning everyone, and congratulations on the quarter, especially on the sales front.

Thank you, Pablo.

When you talked about the M&A side of things, can you clarify that a little bit in terms of looking at distressed assets in Canada? I mean, what specifically are you missing? And related to that, you only own 51% of Diamond. Does it make sense to buy their 49% at some point, especially as you begin to use that facility? And then I have a follow-up. Thanks.

So number one, I think, listen, there are lots of investments that we need to assess that may make sense to be a part of Aphria and we'll look at that and where does that come from. I think as we look at there are opportunities within medical, there are opportunities within other processing. We have a tremendous amount of growing capability, as we have over 265,000 kilos that we can grow today. But I think with any industry, consolidation is important and consolidation is going to happen. I think that's going to be something that's going to happen in the cannabis industry and that's going to be based on smart opportunities. You know, Pablo, we included together 55 acquisitions. So that's something we will look at; is there an opportunity to buy distressed assets or assets that are way undervalued? In regards to Aphria Diamond, we have a great partner in the Mastronardi's, and I think partnership is not only about owning 100%; it's also about having partners that can really help you with your grow and run the facility effectively. So there is no need for us to go out there and buy the other 49% because right now, we're able to get good growth, good products, and good partners, and why would we spend our money to do that?

Understood. And just a follow-up on 2.0, just to be clear, remind us of - in the February quarter, you had your full line-up there in terms of vapes, or was it rolled out through the quarter? I'm just trying to understand most of the launches won't be until June, as you just said, but is there a difference in terms of how much product you will have out there in the May quarter versus the February quarter? Thanks.

So far, it was minimal and really didn't start till January and some in February, but the quarter - the April - the March, April, May quarters are the big quarters that we're going to be rolling out product. That's where the majority of our vapes will be in the next six months. But this will be a good-sized quarter for vapes.

Our next question comes from the line of Graeme Kreindler with Eight Capital. Please go ahead. Your line is open.

Just as a follow-up on the derivatives. I'd like to get if you could provide some color on the production capacity right now for derivatives in 2.0 products kind of from the extraction angle down to downstream packaging, and given the commentary on COVID-19 as well as the CapEx? I'm just wondering if that's going to impact any incremental licensing that might be required to ramp up production of vapes as well as given the market conditions, is that - will that inform any speed up or slow down of product launches as we see what happens at the brick and mortar angle here? Thank you.

So there may be some other licenses and opportunities out there as we're continuously looking at interesting technology and better vaping opportunities. We're also looking at potential partnerships as some of the other companies that do vape today realize cannabis is going to be something that's here to stay. So there are opportunities in partnerships, opportunities in innovation, and we're seeing a lot of new technology out there, and we look to improve products and improve performance, and vaping will be a product that's going to be used in many different occasions. Regarding our other products, again, we've been a little slower than some companies, but it's been because we want to make sure we perfect the right product and that the right products are out there, and they should be rolling out in the second half of our fiscal year 2021.

And just to clarify, in addition, when talking about licensing, in particular with Health Canada, are there any areas that you're currently waiting for licensing that's going to help on the processing side of things, and has the COVID-19 situation impacted any of the expected timing of when you might receive that licensing if that's the case?

Nothing significant. We're always potentially looking for licensing in certain processing rooms and areas, but it's not like a license that we are waiting for Aphria Diamond or nothing that we're waiting for from Aphria One. There could be some small licenses we're looking for in certain rooms within Aphria One or Aphria Diamond, but nothing that will hinder growth in any of our major processing.

Our next question comes from the line of Matt Bottomley with Canaccord Genuity. Please go ahead. Your line is open.

I want to go back, Carl, to some of your commentary with respect to the lack of write-offs and impairments; and that's something that obviously has been challenging sector-wide with a lot of downward surprises by many of your peers. So I'm just curious on maybe the rationale or the philosophy about when you guys bring that biological asset into inventory. I don't know if you can get into the details of pricing assumptions, but maybe just the overall - the methodology of how you're confident that the way you're costing that is ahead of the curve, given what many anticipate is going to be a commoditization as the sector evolves. I think that you commented on in the past that you're not as bearish on that, particularly with your product lineup. But just to mitigate potential future risks of impairments, just given how much capacity is out there.

So one of the key pieces is that when we started as a company, we've always taken the most conservative view of fair value. As a result, we haven't had to pay the price that other people have had to pay for aggression. We've been very clear and transparent in our disclosure in our financial statements. Our cost structure has been lower than everyone else's. Our actual - the real cost before you get into the artificial accounting costs of fair value are generally lower than everyone else in the industry to begin with. And then when you pare that with being very careful on the value that we're writing the product up to, which again we provide full transparency on in the MD&A, it just puts us in a better position. We proactively are looking at where market prices are for all of our products, and if there is a future need to adjust the fair value we write the product up to, we'll deal with that, but at - to this point, those values have been easily recoverable. I think it's just a function of not being aggressive early on.

Got it. That's very helpful. And then just a quick follow-up. And I think, Irwin, you had already commented on this a little bit previously. But when it comes to the Cannabis 2.0 rollout, just confirming that it seems like that big healthy growth you saw in adult-use was more in the dry flowers. So I'm imagining there wasn't a sort of step function increase this quarter on vapes, and if anything, we should anticipate a bit of that in your final fiscal quarter this year.

Exactly. I mean there are some vapes in the quarter. But the fourth quarter is the quarter we're in now, which ends at the end of May, is where the big step-up is in vapes, and then in the first quarter of 2021. In the back half of 2021, our second quarter and third quarter, that's when we go into edibles and gummies and other products.

This concludes the Q&A session for today's call. I will now turn the call back over to management.

Thank you very much, Kensey. Thank you everybody for today's call and spending time listening to us. It's been just a year now that I've taken over as CEO, and it has been really, really interesting. It's been an interesting industry, and I've really enjoyed working with the people at Aphria. I've enjoyed working with our Board. I've enjoyed very much working with our consumers, our analysts, and the financial world. This is an industry that has tremendous potential in so many different areas, whether it's recreational, medical, or other medical aspects of it, etc. And I think what you'll see today is Aphria playing a big part. Just think of what we've been able to achieve within the year regarding our brand building, our cash situation, our balance sheet, building out Aphria Diamond, completing Aphria One, building out Germany, building out LATAM, and completing that. So with that, just as you give us more and more time, think about what we will be within the cannabis world. There will be consolidation, and there will be additional partnerships that come, and Aphria will be a big part of that. But I think the most important thing is we are in changing times. I've never seen this in my lifetime, and I hope I never see something like this again in our lifetime. One thing we got to take into effect: the consumer will change; our purchasing habits will change, the way we socialize with people, what we do with our employees, and how we sell products. Aphria today is in a good place. We have revenue, we have brands, we have cash, and we're running every single day. Every day we think about the safety of our employees, what is going on in the world, and how we give back, and we will continuously give back in every way we can. So with that, I'd like to tell everybody, please be safe, use social distancing, stay home, relax, enjoy some great recreational cannabis, enjoy some medical, and you'll be safe, happy, and look forward to talking to you real soon. Thank you very much for today's call.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.